I recently started working with a 47 year old man; he has been divorced for 10 years and has two children. He felt that he was out of control with his finances and wanted to plan for the future.
After sorting out his everyday expenses we started long term financial planning. I asked him whether he has a pension, to which he replied he does. In Israel, since 2008, a law was passed that every employer had to pay into the employee pension fund and if they do not comply with this law it is considered a criminal act and legal charges can be brought against them. I asked him how much was saved in the fund and what amount he is expected to receive as a pension, he looked at me blankly. I explained that he will most probably be receiving a pension for about 20+ years. I asked him whether he would take a job for 20 years without knowing the salary, to which he replied ‘no’. In my opinion, there is no difference between a salary and a pension.
The statistic show that nowadays people are living longer, for men the average age is 81 and women is 84 and it keeps getting longer. A quick calculation on Google, my client can expect to live to the ripe old age of 86.
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Actuaries are calculating that people, who are facing retirement today, can expect to live until the age of 85 for men and 87.5 for women. People in their 20s can expect to reach 90+. It is quite clear that pension planning is critical for people who are working today than people who are soon to retire. Old pension schemes are based on the fact that people will be living for about 20 years after retiring and new pensions schemes have to accommodate increased longevity.
If longevity runs in your family and you are in relatively good health how do you ensure that you will have enough money until your end of days? We are lucky that in Israel, that no matter how much money you have accumulated in either your Bituach Menhalim or Keren Pensia, the two popular pension schemes, you are guaranteed that no matter how long you live, you will always receive a monthly pension allowance. This default in our pension plan is encouraged by the government via tax benefits for the employer and certainly for the self-employed. I would recommend that everybody who has a pension scheme makes sure that the longevity clause is included.
As a Family Financial Advisor I am fully aware that there are two financial goals that we now need to take into consideration in doing long term financial planning. The emphasis in the 20th Century was real estate and now in the 21st Century pensions has been added to the list and they should not compromise one another.
In this article I will explain the common mistakes that people make with their pension and even missing out one month of your pension payment can cost you thousands of shekels.
The first common mistake is that people have no idea what pension plan they have or how much they are expected to receive as a pension. This information is crucial for financial planning. Governments around the world have shaken responsibility in providing a pension. The Bituach Leumi old age allowance is a pittance and one cannot live off just this amount.
Therefore making sure that you have a good pension scheme is now your responsibility. Understand your pension policy, sit once a year with your Insurance Agent and ask them to explain it in a language and terminology that you can comprehend and always take notes in this meeting.
The second mistake that I have found that people make and this applies especially to the self-employed. In 2017 the Government passed a law that all self-employed people have to pay into a pension scheme. However, the self-employed do not save enough. The earlier you start saving the more compound interest you can earn on your pension. Yoram Leviant, a pension planning expert and a member of the Israeli Union of Family Financial Advisors, to which I also belong to, explains that 50% of the amount that you will receive as a pension comes from the amount saved between the ages of 27-37. Between the ages of 38-47, 25% and from 48-67 another 25% of your pension amount. Therefore, everybody working, whether you are just starting out or not, it is vital that you have a pension and to keep it active.
The third mistake is that when we are unemployed, or on unpaid vacation leave like during the Coronvirus crisis, people do not carry on making monthly contributions to their pension fund. If the fund does not receive payment after 6 months it becomes null and void and therefore dormant. This means you will have to start a new pension fund when you commence employment again. During the Coronavirus crisis instead of the 6 month period that the policy can be frozen it was extended to 12 months.
IMPORTANT: if this is you, in the month of March, this grace period now expires and action needs to be taken immediately. During the grace period most Insurance Agents will recommend that you just pay the risk, your life insurance, since this sum is normally quite low. However, I also recommend you paying into your pension scheme as well. Let me illustrate what is the consequence if you do not pay into your pension fund. The following calculation is prepared by Beni Schuri also a member of the Union of the Family Financial Advisors.
Your salary is NIS 10,000 and the combined monthly payments, from you and your employer, is NIS 2,083 and if the fund does not receive any payment for 6 months the loss is NIS 12,498.
Let us now calculate how much you will lose in the long term.
|Your salary||NIS 10,000|
|Amount not deposited for the 6 months period||NIS 12,498|
|Age 57 – 10 years before retiring||NIS 12,087|
|Age 47 – 20 years before retiring||NIS 35,865|
|Age 37 – 30 years before retiring||NIS 82,639|
|Age 27 – 40 years before retiring||NIS 174,652|
*calculate on the basis of 7% yield which is the average
The formula is for every NIS 100,000 you receive NIS 500 monthly pension. Therefore, not paying into the scheme has quite an impact on your monthly pension allowance.
Also it is imperative that when you start work again and especially now, after the coronavirus crises, that you start paying into your pension fund immediately after the first month. If you have an existing policy, the employer is required by law to pay into your pension scheme after the third month but retroactive. If you don’t have an active pension scheme or you do not have any pension scheme at all, in both cases a new pension policy needs to be opened, the law does not require the employer to pay retroactive. This means that you will lose 6 months of pension payments and as illustrated from the chart it has a huge impact on your future monthly pension allowance, especially if you are between the ages of 27-37. If you were on unpaid vacation, your employer must deposit immediately from the date you returned back to work. Remember, wherever you work, whether you have an existing policy or starting a new one, the pension should be paid from the first month and have this stipulated in your work contract.
The fourth and most common mistake is that people withdraw from their pension fund. Here in Israel, the pension is divided up into three parts, Life Insurance, Pension and a Compensation Fund. The pension and the compensation fund are combined together to pay your monthly pension. The employer is required by law, if they fire you, to pay compensation. If you quit, most employers will release the compensation fund. How much compensation are you entitled to? The formula is the last pay check times the years that you worked. For example if you worked for 10 years and your last salary was NIS 10,000 you are entitled to NIS 100,000. Though when you started to work your starting salary was NIS 6,000. The compensation fund will not have NIS 100,000 but less since you started on a smaller salary. People make the common mistake that they will withdraw the whole amount they are entitled to, including what is in the compensation fund, which is part of your pension. The only amount that you should receive is the balance which is not in the fund and the employer pays this amount you do not receive the cheque from the insurance company.
Let me illustrate how important this is by a parable that I heard when I was a child. A farmer agreed with the lord of the manor that for every bushel of wheat, he would put a coin in a bowl so that they will know how many bushels there were. Half way through the harvest the farmer saw the bowl filling up with coins and got angry and said “I need this money” and took some of the coins back. He did not replenish the coins taken and at the end of the harvest the lord of the manor counted the coins and for every coin in the bowl, the farmer received a gold coin. Therefore, the farmer lost out in the long run. It is the same case here, do not withdraw funds from your pension scheme, since you will receive less in your monthly pension.
If you do have to withdraw from the compensation fund, I would highly recommend going to the Income Tax Office to see how much tax you need to pay on the amount. I know that nobody likes to go the Income Tax Authorities but here they can work to your advantage. Research has found the people from the low social economic scale do not do this and they paid too much tax.
The last and final mistake. When you leave a place of employment the employer will issue a 161 form. The 161 form proves that you have worked and that your employer made all the relevant financial contributions. When you receive this form, put it in a safe, like with your will, since you will have to show it to the tax authorities upon retirement. If you do not have the 161 form from a certain place of employment, try issuing one when the business has closed.
To summarize, pensions in the 21ST Century needs to be pushed up to top priority in financial planning. I suggest that you follow these tips. If you are employed, check your salary slip that the employer has deducted your pension from your salary, and make sure that it is in compliance with your contract. Then every year when you receive the pension report make sure that the amounts were deposited into your pension fund. Also when checking the report, make sure that you are paying the right amount in management fees, since this also has a huge impact on your pension. Remember to sit with your insurance agent at least once a year. If you are self-employed, pay as much as you can into your pension fund and start as early as possible.
With my 47 year client, I recommended that he sit with a reputable pension advisor to help him plan his pension since there is no time like the present to start planning. This meeting will enable my client to retire and enjoy his retirement. So in 20 years’ time, after he has worked hard all his life, he will live out the rest of his days in comfort like he deserves and so do you.